September 30, 2005

The Saving Rate Increases - And That Ain't Good News

U.S. consumer spending fell an unexpectedly steep 0.5 percent in August, the biggest drop since November 2001, according to a government report Friday that also showed a surprise income decline potentially caused by Hurricane Katrina...

The spending decline pushed up the saving rate, the percentage of disposable income saved, to negative 0.7 percent from July's record low of minus 1.1 percent. A negative saving rate shows U.S. consumers eating into their accumulated wealth to spend.

Admittedly, that's not much of an increase, and it's not clear anyone is expecting it to stick.

Although spending proved weaker than expected in August as auto purchases plummeted, the decline followed two months in which consumers spent freely. Economists said the fall was not particularly troubling.

"The drop in August is just a pullback from that earlier surge in spending," said Gary Thayer, chief economist at A.G. Edwards and Sons in St. Louis.

As to the inflation side of the report:

The fall in spending came as energy prices pushed consumer inflation up 0.5 percent, the largest jump since September 1990, the Commerce Department said.

Outside volatile food and energy costs, inflation as measured by the Federal Reserve's favorite gauge edged up 0.2 percent. Over the past year, so-called core inflation has climbed 2 percent, a tick faster than in the 12 months through July.

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Inflation In The Eurozone

The near-term fortunes of the euro's purchasing power is looking a lot that of the dollar. From Bloomberg:

Inflation in the dozen nations sharing the euro accelerated in September to the fastest pace in more than a year after oil prices surged to a record.

Consumer prices rose 2.5 percent from a year earlier, after increasing 2.2 percent in August, Eurostat, the European Union's Luxembourg-based statistics office, said today. That was the biggest annual gain since May 2004 and topped the 2.4 percent median estimate of 32 economists surveyed by Bloomberg. A separate report from the Brussels-based European Commission showed consumers and executives anticipate rising prices.

One difference between the U.S. and Eurozone, of course, is that the European Central Bank has an explicit inflation target and the Federal Reserve does not.

A 53 percent increase in the price of crude oil this year pushed inflation beyond the European Central Bank's target of just below 2 percent for eight months. That's prompting ECB council members including Yves Mersch and Axel Weber to say the Frankfurt- based bank is concerned about prices, suggesting its next shift on interest rates may be an increase.

Nonetheless:

The ECB's governing council next sets its benchmark interest rate Oct. 6 and 29 economists surveyed by Bloomberg are unanimous in expecting it to leave it unchanged.

One reason for that may be that the data is not clearly speaking to a pick up in the inflation trend:

The euro-area's so-called core rate of inflation, which excludes energy and food prices, held at 1.3 percent in August, the lowest since February 2001. Eurostat will publish a breakdown of September's data on Oct. 18.

Another reason might be that inflation expectations appear to have stabilized. From Reuters:

ECB policymakers regularly cite the low level of expected inflation as a reason not to raise interest rates...

The break-even rate [one commonly used measure of market inflation expectations] is the difference in yields between inflation-indexed and normal government bonds. Very roughly it represents the average annual inflation rate that bondholders expect over the life of a bond.

The 10-year BEIR rose steadily from a trough of 1.7 percent in June 2003 --just before the ECB cut interest rates to a historic 2 percent low -- to a peak of around 2.3 percent a year later, and has since slid back to about 2.0 percent, according to data in the ECB's September bulletin.

The Reuters article does note that the "break-even rate" is not without its problems:

One thing analysts and the ECB do agree is that it is misleading to read the BEIR as a simple predictor of future inflation.

For example, the relative illiquidity of euro-denominated index-linked bonds compared with nominal bonds tends to give the BEIR a downwards bias. But their value as a hedge against inflation and their popularity with some pension funds attempting to match index-linked liabilities pushes the BEIR upwards.

Each effect might be in the region of tenths of percentage points, but it is unclear what the net impact is. This means the ECB and analysts prefer to look at changes in the level of the break-even rate, rather than its absolute level.

Even here, there is a question mark over whether the liquidity premiums on index-linked bonds remain the same over time -- not a certainty as issuance of these bonds increases.

The BIER measure is similar to the "TIPS" measure of inflation expectations in the U.S., which is subject to similar criticisms. That said:

Given these caveats, most economists say the BEIR is probably the best of an imperfect range of options for the ECB. "It's a worthy part of the armoury, but by no means a weapon that can be used on its own," James said.

For now, at least one member of the ECB wants you to know they are on the case. From Bloomberg:

European Central Bank council member Yves Mersch said oil prices at current levels risk boosting wages and feeding inflation, suggesting he may support an increase as the bank's next step on interest rates.

"The longer the oil prices remain high, the higher the risks are that second-round effects will also materialize,'' Mersch said in an interview at an event in Luxembourg late yesterday. "That's the reason why we called for particular vigilance.''

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Is ECB using U.S. cpi methodology for calculating inflation? How different is their reporting/calcing system? It seems implausible that the ECB would have a BLS type team with the equivalent of our 40,000 or so part-timers in the fireld recording current prices, or that it is making so many subjective decisions, i.e. what percentage is housing, & how does it determine "rental equivalency"? For that matter I don't know if the ECB collects data or relies upon individual countries. I've gotten nowhere looking on the WEB for this info., this is why I've been pleading for a global forum to standardize economic reporting.

Bailey-- The ECB uses Harmonized Price Indexes (HICP's) when computing "European" inflation. These HICP's can be much different than the CPI's computed independently for each country (although I believe the data used to compute these numbers are obtainded from the statistical agencies of each nation according to standards set down by the Eurostat, but I'm not 100 percent sure of that.) In a nutshell, the difference between the HICP method and the CPI you are familiar with is that the former includes only those items a household actually spends money on for final consumption. So things paid for on your behalf by an employer or government (e.g. healthcare for many), and ANY imputed costs (like housing), are not in these measures. Indeed, the last I looked, there were no housing costs in these measures whatsoever. So the marketbasket implied by the HICP measure is much more narrow than your ordinary CPI. Some of this is due to the difficulty of producing these numbers and the speed at which the EMU was put together. I believe that over time, the HICP's are getting broader and more sophisticated in their approach. Be careful though, while high quality data is what we all desire (and is being pushed pretty hard), I think, standardization is not always a desireable thing. I suspect that the cost-of-living measure that is appropriate for your life might look a lot different than the one appropriate for me.

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The Conference Board Consumer Confidence Index, which had rebounded in August, plummeted in September. The Index now stands at 86.6 (1985=100), down from 105.5 in August. The Present Situation Index decreased to 108.9 from 123.8. The Expectations Index fell to 71.7 from 93.3 last month...

“Hurricane Katrina, coupled with soaring gasoline prices and a less optimistic job outlook, has pushed consumer confidence to its lowest level in nearly two years (81.7 in October 2003) and created a degree of uncertainty and concern about the short-term future,” says Lynn Franco, Director of The Conference Board Consumer Research Center. “Historically, shocks have had a short-term impact on consumer confidence, especially on consumers’ expectations. Fuel prices remain high, though they have retreated in recent days, and when combined with a weaker job market outlook, will likely curb both confidence and spending for the short-run. As rebuilding efforts take hold and job growth gains momentum, consumers’ confidence should rebound and return to more positive levels by year-end or early 2006.”

Confidence among French executives and German consumers declined in September, the latest evidence that near-record oil prices are threatening the outlook for economic growth across the dozen-nation euro region.

In the opposite corner, European businesses appear to be feeling much better, thank you:

In Italy, Europe's fourth-largest economy, business confidence unexpectedly rose to a 10-month high in September, the Rome-based Isae Institute's said...

Business confidence in Germany, Europe's largest economy, unexpectedly rose to an eight-month high in September as the euro's 11 percent decline against the dollar this year made the country's goods cheaper abroad, the Munich-based Ifo institute said yesterday.

...the Commerce Department said new home sales fell 9.9 percent, to an annualized pace of 1.24 million, from a record-setting July, and were at their slowest pace since January. There was a 4.7-month supply of homes on the market in August, up from a 4.1-month supply in July. The median sale price, however, rose 2.5 percent, to $220,300. Economists had been expecting an annualized pace of 1.35 million new home sales.

By comparison, the National Association of Realtors said Monday that existing home sales rose 2 percent, to an annual rate of 7.29 million, in August and the median sale price hit a record of $220,000, up 15.8 percent from a year earlier. Existing homes make up about 85 percent of all home sales."You shouldn't think that this is a sign of apocalypse now, that things are collapsing on us," Anthony Chan, an economist with J. P. Morgan Chase, said of the new home sales data. "This is clearly not that. When I look at these numbers, I see that this is a year that most Realtors would be proud of."

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Small businesses get MANY Gov't. ks, consumer's lost most of his. Remember when credit card debt was deductable? Now it's not, banks are charging as much as 25% interest for incollateralized cards & consumers must pay up even to go bankrupt. Further, their paymments pegged to cpi are grossly unestimated, they have lost any wage barganing power as they've wathed medical, college, driving & home costs skyrocket. 30% of population are NOT homeowners and you wonder why they're not as positive as businesses? How many of these folks who don't already own a house can afford to buy a median priced house today? My bet is every small business owner in the world is writing off their gas expenses. How secure is YOUR retirement plan? Want to compare it to what most consumers have?
P.S. I believe DG contains airplane orders deliverable three years down the road & cancellable on a phonecall. Lastly, aren't companies paying the lowest taxes in history, down phenominally in the last 20 years?

Hope I didn't shut off comments with my shrill outburst. I'm fed up with all the postmodernist rhetoric. The Fed's got a job to do. It's wrong for it to want to "feel" out public's readiness to accept a tough course. We are all aware of the difference in public attitude toward infation in Burns & Volcker terms. I think the only question of relevance now is Fed credibility. 5% here we come.

Not at all bailey. I couldn't agree more and if you spit some data into the Taylor Rule function you come up with ~5.25% Fed Funds. There's no question that the Fed has more work to do, but what are the chances they ignore aggregate measures of CPI and just focus on the PCE deflator and end up making a monumental policy error by stopping/easing too soon?

Huge concern! My wildest hope is that AG will use wear his pulpit thin in the next few months & a few academics will voice support. But, I recognize it's a real longshot; who's ready to take on the holy grail?

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-- Econbrowser kicks out another must-read post on the origins of the U.S. current account deficit. Jim is worried. Mark Thoma helps out with some advice from The Economist. The bottom line -- the U.S. should save more, China and other emerging-economy countries should save less.

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Morning Round Up, Housing Edition

Federal Reserve Chairman Alan Greenspan, drawing
on new research he has personally supervised, said American consumers
have become enormously dependent on borrowing against their homes to
fuel their spending, and that a rise in mortgage rates could trigger a
spending pullback.

Simple: by giving a tax subsidy to housing, it distorts investment
decisions toward houses and away from assets like factories and
equipment that are more productive at the margin. And that makes
workers less productive, ultimately lowering wages and making society
poorer.

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Actually, it is not allowing interest deductions causes distortion. Under the income tax, it is income that should be taxed, not everyones favorite whipping boy.

The problem is factories and equipment are no longer more productive than housing and can no longer attract investment dollars. It is too cheap to substitute emerging market labor for expensive equipment and no longer makes sense to make those kinds of investments. This is yesterdays thinking.

On Sept.26 National Association of Realtors reported that the sales of previously owned homes surged in Aug., the median price rose 15.8 percent in the last 12 months. When homes are the object of speculation, this 15.8 percent could be regarded as "yield", and so long as expectations exist for the “yield” to exceed the expected borrowing rate, the speculations never ends.Some other policies are needed.

Usually one cites the half century or so of falling manufacturing/total labor ratio in this country, to stem those whining about offshoring. This recent period, say 2000 onwards, is different. Many come to the conclusion that nothing is"more productive than housing" and point to GDP stats in this period to support this claim.
More profitable maybe for now ( review the profitability of UK housing over the past year), but not more productive.

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Mr Sarkozy said this G6 - France, Germany, the UK, Italy, Spain and
Poland - should make collective proposals to other EU leaders. The
other members could accept or reject these proposals, but they should
not be able to prevent the G6 from pursuing them.

While
most investors suspected there was wholesale diversification from USD
holdings by major central banks, the IMF’s data paint a very different
picture. The volume of EUR purchases last year was significantly less
(about half) than the share of EUR holdings in total reserves at
end-2003.

The latest IMF report shows global holdings of official reserves in USDs rose from 65.8% to 65.9%.

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The estimation wizards are still not quite comfortable in posting the results for the December meeting. I will tell you this much -- it does not appear that a clear pause/no-pause sentiment has yet emerged. I will update if more information is made available.

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The last few weeks seem evidence enough that the equity market can't see in front of itself, let alone two months down the road. I believe it would be way out of character for AG to interrupt a policy he believes in just because he's on the way out the door. Let's not forget his early Spring comment, that mortgages won't be affected by rate increases until mtg. rates touch 7%, & even then only minimally.

AG talked today like he was kicking off a p.r. campaign to prepare us for tougher monitary policy down the road. Maybe he's lobbying to influence selection criteria for his successor. We now do know he's CONVINCED two 1/4 point ff increases (Nov. & Dec.) will not be enough. We also know the world's awash with liquidity & the U.S. consumer-homeowner is not prepared for the shock that's ahead. But, we don't know who Bush will pick to replace AG, and we don't know why Bush has TWO Fed Governor seats open.

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What Should You Know About Economics?

In case you haven't seen it yet, Russell Roberts and William Polley have a discussion of "what the public doesn't know about economics" in the latest edition of the Wall Street Journal's Econoblog feature. On this topic, I have lately had the opportunity to interview a number of economists about various things, as part of an exhibit that is being developed for a soon-to-be-finished learning center at the Federal Reserve Bank of Cleveland. I generally ask different questions of different people, but try to ask this one of everyone: If there was one lesson from economics that you could magically implant into the brain of everyone, what would it be?

You'll be able to see these answers yourself in the near future, but my answer would be this: Trade is good.

Whether your an "official" economist or not, feel free to leave your own opinion in the comment section.

"Trade is good" is tricky, because it has been on so many lists of "one lesson we should take from economics" that it is becoming repetitive. (Sorry, this isn't the first.) Good why? I understand the static gains (consumer surplus) generated by trade are not large, as a share of GDP. Is it the rise in welfare from Smithian specialization that impresses you, or is it some other virtue of trade? I am quite willing to back trade for the benefits in terms of technology diffusion, discipline of local firms and the like. Or is the point that there are so many good things that its inclusion is self-evident?

I like "trade is good" though unqualified workers in advanced economies would be a tough nut to crack in this regard.

One of my own favourites is "governments have less influence on the economy in the short run than they would wish and more influence in the long run than they imagine". But I guess it does'nt qualify as a snap quote. It takes an american to carve a snap quote.

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Debt Relief

The World Bank and International
Monetary Fund concluded their annual meetings yesterday with an
agreement to write off as much as $57.5 billion in debt to ease
the burden on impoverished countries...

The debt-relief package, an endorsement of the initiative
agreed to by the Group of Eight major industrialized countries in
July, would wipe out the debts that the poorest of nations owe to
the World Bank, IMF and African Development Bank. The proposal is
being sent to the executive boards of those institutions for final
approval, World Bank President Paul Wolfowitz said...

One of the main sticking points heading into the meetings was
concern about the drain on the World Bank's budget once it wrote
off so much debt -- eliminating the repayments the bank has come
to depend on to finance its operations. Roughly $42.5 billion of
the total amount of debt write-off is tied to the World Bank's
International Development Association.

The G-8 countries on Sept. 23 sought to address that by
pledging additional money out of their pockets to ensure that
there would be no reduction of resources at the World Bank or the
IMF.

The proposal the IMF and World Bank policymaking committees
agreed to in the end calls for prompt ``dollar for dollar''
compensation to help maintain the other programs for poor nations,
according to a report by a joint committee for the institutions.

The WSJ article also makes it clear that the negotiators were cognizant of this plan being seen as a reward for bad behavior:

... some [IMF] member nations thought it unfair to forgive
loans to poor nations with huge debts but not provide equal treatment
for poor countries that had better managed their borrowing. In the end,
IMF governors backed a plan to offer debt relief to any member nation
with an annual per capita income of less than $380, regardless of its
credit problems...

The benefits will go first to 18 countries that
have been certified as having sufficiently prudent economic policies to
qualify. An additional 22 nations may qualify, but still have to clear
the bar by sticking to economic plans that satisfy IMF economists.
Together, those countries owe some $55 billion to the IMF, World Bank
and the smaller African Development Bank.

The article characterizes paying off poor countries that did not manage their debt well as "unfair", but economists would generally stress the moral hazard problem: Forbearance for poor policy may just induce more poor policy. That the issue was raised, and an attempt made to address it, is a good thing.

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September 23, 2005

The Chinese Central Bank Back In Action (Sort Of)

China's central bank has widened the yuan's trading band against the euro, yen and Hong Kong dollar, another step toward currency flexibility ahead of weekend finance meetings expected to bring some heat on the Chinese leadership.

The People's Bank of China said in a statement that it has widened the yuan's trading band against non-U.S. dollar currencies to 3% from 1.5%.

"Gradually the (People's Bank of China) will carry out fewer and fewer interventions in the foreign exchange market and let the market decide," Hu Xiaolian, deputy governor at the central bank, told the publication "Emerging Markets"...

But Hu, who is also China's foreign exchange chief, added: "We think it's still an open question as to whether the (yuan) exchange rate is undervalued."

"We can't expect the move will change the activity or strategy of the (central bank) in the foreign-exchange market overnight," Hu told the publication.

She said China still needed to take steps to ensure speculative inflows do not destabilize the economy.

"We should first further develop our capital markets and other domestic institutions, to better use our domestic market to finance business," she said. "We have to implement all kinds of control on this hot money. We have to keep our watch on capital inflows."

"We've repeated this many times: a stable exchange rate is in China's best interest," Hu said.

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Tang Xu, head of reaseach at the People's Bank of China reports that July's foreign reserves hit $740B up +$29B from June. He says the country hasn't detected any "abnormal" capital inflows since the pace is the same as last years.

At $740B the foreign reserves are about 44% of GDP and annualizing the monthly $29B puts the annual capital inflow at $348B or 20% of GDP.

Since China has about a $31B net annual trade surplus it would seem that $318B in "normal" capital flows are occurring.

If this is normal and thus isn't worrying Chinese officials I wonder what it would take for them to get nervous.

I don't know about you all, but I'd be plenty nervous. Just think if the Chinese equivalent foreign reserves were coming into the U.S. which would be $2.3T per year.

Such a hugh amount of FER ( amounting to $800 Billion in 2005 on a cumulative basis is really horrifyinga and if it adds up to 44-50% of China's GDP is really amazing if you look at the Country's net GDP and if Yuan is not undervalued, I wonder how the self-regulating mechanism can square off the pressure of Yuan not to continue appreciating but China is obviously using the visible hand as well as its administrative means gifted by the Socialism to withstand the international pressure in not to revalue Yuan.besides, just buying into Treasuries ot Government Agency Bonds could help a bit but it does not solve the actual problem because Yuan is awkwardly undervalued so that I tend to believe there is a trend for Yuan to continue appreciating no matter what sort of excuse you would like to say you are not.

Anyhow, China is already part of the World Economy, it should have the responsibility to bear the brunt of economic realities instead of hiding its head in the sand again.

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